Code Red: Two Economists Examine the U.S. Healthcare System

January 19, 2017

Can President Trump Reduce Drug Prices? Should He?

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 11:03 am

We’re back. Trump is tweeting and we are blogging. Welcome to the brave new world that is 2017

A note from the older member of the writing team that will explain our hiatus (Dranove, in case you didn’t know): In the fall of 2015, I was asked to advise the Department of Justice on Anthem/Cigna insurance merger.  I went on to serve as the economics expert at trial.  During this period, I chose to suspend my blogging and Craig didn’t want to break up the band so he also took a hiatus. That trial wrapped up two weeks ago and I am once again ready to opine on all matters health economic. (Well nearly all; for now I will still refrain from commenting on matters relevant to the trial.)

We have written many times about the strengths and weaknesses of the Affordable Care Act. With a new sheriff in DC, it seems highly likely that the ACA will be dismantled, perhaps piecemeal, perhaps in its entirety.  It is difficult to discern President Trump’s and/or the Republican leadership’s intentions for a replacement, but it seems clear that they will need to find new ways to hold down health spending. Given his vague statements on the campaign trail, it should be surprising that Trump has taken at least one public position in this regard – he intends to drive down the prices for brand name drugs by allowing “bidding” by government agencies (i.e. Medicare). We note that he also said he would allow bidding by Medicaid, but Medicaid already receives the lowest price on the market by statute so we can’t imagine bidding would do much for them.

He supports this goal with the statement that pharmaceutical firms and their lobbyists have been getting away with “murder.” While there are many bad actors that have emerged in this sector, we both believe that this is at best a simplistic characterization of this market. Perhaps more concerning is that such an effort to lower prices will take large amounts of effort and political capital with at best a modest effect and possibly quite negative outcomes. This might be why Trump’s nominee for HHS secretary was far more skeptical of this plan.

We understand and sympathize with the superficial attractiveness of this goal. The prices of many widely prescribed drugs are far higher in the US than the rest of the world. Bloomberg News recently reported the average prices paid for eight top selling drugs in the US and a dozen other nations. All prices were net of any discounts offered by the drug makers. With one exception (Hepatitis C treatment Sovaldi was slightly more expensive in Saudi Arabia), prices were always higher in the US. And the differentials are not small. The price for a one month regimen of Abbvie’s biologic Humira is $2500 in the US, versus $1700 in Germany (which generally pays the second highest prices.). Roche’s breast cancer infusion drug Herceptin costs $4700 per month in the US versus $3200 in Germany, while Novartis gets over $10,000 for a one-month supply of its Leukemia drug Gleevec, versus $3000 in Germany.

The overall savings from reducing US drug prices to the levels paid by others countries could be fairly substantial, as seen by a bit of math. We estimate that US spending on drugs and devices accounts for as much as 20 percent of total health spending (including spending in hospitals.) Spending on branded drugs and patented devices may represent approximately 80 percent of this total. Several studies suggest that post-rebate prices of branded drugs in the US are, on average, at least 20 percent higher than in Europe and elsewhere. Eliminate the price differential and total health spending could fall by 3 percent or roughly $100 billion. Why not go for it? However, as economists often note, a little more analysis shows that it’s unlikely you will simply be able to find $100 billion laying on the sidewalk. If it was that easy, some previous administration would have scooped up that money.

Supporters of allowing Medicare to bid for drugs argue that this is all just a simple matter of purchasing power – the US is the largest consumer of drugs, so why shouldn’t we get the best prices? As Trump says, “We’re the largest buyer of drugs in the world, and yet we don’t bid properly.” If he means that bidding properly is simply a function of your size, this is at best a naïve understanding of how negotiations work, which some might see as ironic. Simply put, size alone won’t do the trick. If it did, then United Healthcare, Express Scripts, and other large US purchasers would all pay lower prices than many nations, including Canada. Indeed, size alone never explains pricing, unless size generates some scale economy in production, something that is lacking in this market.

Nor should we expect drug makers to simply accede to demands for lower prices. Drug makers routinely face these demands from every nation and are unlikely to cave unless they have a better reason than “We’re big and we want to pay less.” As any experienced negotiator knows, two key factors will ultimately determine the prices of the drugs we buy – how much the drugs are worth to us, and how willing we are to walk away from the deal. Right now, other nations have the negotiation edge on both fronts. If we are to approach pricing parity across countries, some things have to change, either here or in the rest of the world.

When deciding whether and how much to pay for drugs, most industrialized nations rely to a certain extent on cost-effectiveness analysis. And if a drug is not cost-effective, then the health system refuses to pay for it. (See, for example, the recent decision in the United Kingdom to move the oncology product Kadcyla from the routine coverage list because of its cost.)  Both key factors mentioned above are at play here. First, research by Harvard’s Kip Viscusi and others shows that Americans place a higher value on life than anyone else. This leads everyone else to adopt a relatively low cost-effectiveness threshold, which means prices must be low (or the benefits quite high) or the product won’t win approval. Second, if patients in other nations don’t like it when their health system refuses to turn down a drug, they have nowhere else to turn – the system is effectively an insurance monopoly. If a US insurer refuses coverage, employers might turn elsewhere. The insurer might even face a lawsuit as we have seen in the case of the reluctance of both public and private insurers to initially provide access to the expensive Hepatitis C cure Sovaldi. In other words, national health systems can and do credibly threaten to walk away from coverage. Facing competition and litigation, U.S. insurers cannot do the same.

So how can we achieve parity? A good first step would be to eliminate rules under Medicare Part D that force insurers to cover many drugs, seemingly regardless of the price. Under Part D, all drugs that are in protected classes such as Oncology, must be included on all formularies, i.e. the insurers don’t have the right to walk-away. Given this fact is common knowledge, it doesn’t take a sophisticated pharmaceutical firm to capture most of the surplus from that negotiation. And private insurers in the under-65 market need some legal protections should they refuse to cover certain drugs, even those drugs approved by Medicare. If the Trump administration truly wants to go further, it could turn Medicare into a monopsony purchaser. But this would not be enough. Medicare would have to be willing to walk away from deals, and this means that some patients will not receive life-saving drugs. After all, if we want European prices, we must accept European restrictions. You can’t have one without the other.

Even if we can push down drug prices, we must ask if we want to. Note that this is a far harder decision for the United States than any other country. We are but one player in a global drug pricing equilibrium in which high US prices subsidize most of the global medical R&D enterprise while the rest of the world free rides off us. If the United Kingdom or Canada doesn’t offer access to a product, this doesn’t have the same effect on the innovative process as the United States. Simply put, if the United States decided to move to European prices, without Europe increasing its prices, we would be determining not just access for our citizens but for the entire world. Without profits from the United States, then the pipeline of R&D will begin to dry up.

So the current situation may be bad for the US but it may be worse if we do something about it. That being said, now may be the time to have a conversation about whether we have “too much” innovation. New drugs that offer relatively incremental improvements are receiving outsized rewards. In addition, we are seeing a pace of spending growth in Medicare that might exceed our national resources – at least a portion of which is a result of Medicare paying for all new treatments. We welcome a conversation on the profit-innovation tradeoff, but realize that this is a far more difficult conversation that involves  hard discussions about the value that we place on life. It certainly is a conversation that requires more than 140 characters.

If we don’t want to discuss the effect of lower prices on innovation, then the hard problem may not be figuring out how to reduce US prices – if we are willing to say no to some drugs, then we can get lower prices. The hard problem may be figuring out how to get the rest of the world to pay higher prices. If President Trump can do that, then he really has mastered the art of the deal.

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